PIM2020 - Deductions: general
matters: repairs

Overview

Repair means the restoration of an asset by replacing subsidiary
parts of the whole asset. An example is the cost of replacing roof
tiles blown off by a storm. There won’t be a repair if a
significant improvement of the asset beyond its original condition
results - that will be capital expenditure. For instance, there
will be a capital improvement if the taxpayer takes off the roof
and builds on another storey.

A repair is normally a revenue expense that can be deducted
in computing rental business profits. Capital expenses are
generally not deductible in computing profits but there was a
limited concession for ‘notional repairs’, which ceased
to have effect from April 2001 (see below). In addition, allowances
are available for certain kinds of capital expenses, such as the
expense of constructing or extending industrial buildings.

Examples of common repairs that are normally deductible in
computing rental business profits include:

exterior and interior painting and
decorating,

stone cleaning,

damp and rot treatment,

mending broken windows, doors, furniture
and machines such as cookers or lifts,

re-pointing, and

replacing roof slates, flashing and
gutters.

This guidance applies equally to CT Schedule A from 1 April
1998.

Further guidance is given in an article in TB59 issued July
2002 entitled ‘Schedule A: computation of profits: repairs to
property’. This is reproduced at the end of this page.

Cost of land and buildings is capital

The cost of land and any buildings on it is capital expenditure.
So is the cost of any new buildings erected after letting has
started and any improvements. Capital expenditure cannot be
deducted in computing the profits of a rental business. Nor can a
revenue deduction be claimed for the depreciation of capital assets
or for any loss on the disposal of capital assets. But there are
separate reliefs for some capital expenditure (see below).

Other examples of capital expenses include:

expenditure which adds to or improves the
land or property; for example, converting a disused barn to a
holiday home,

the cost of refurbishing or repairing a
property bought in a derelict or run-down state,

expenditure on demolishing a derelict
factory to clear space for a new office building; the cost of the
new building,

the cost of building a car park next to a
property that is let,

expenditure on a new access road to a
property,

the cost of a new piece of land next to a
property that is let.

Separate relief for capital expenses

In some cases capital expenditure on a property (but not the
land itself) may qualify for ‘capital allowances’.
These are effectively further deductions in arriving at taxable
rental business profit. In particular, capital allowances are
available for expenditure on certain industrial and agricultural
buildings. Plant or machinery within buildings may qualify, for
example lifts. Allowances may also be due on demolition costs.
There are no capital allowances for the cost or depreciation of
residential property; but a ‘wear and tear’ allowance
may be due for the plant and machinery (furniture, furnishings etc)
within furnished accommodation (
PIM3200). An allowance may also be due
for the cost of installing loft, cavity wall or solid wall
insulation, draught proofing or insulation for hot water systems in
a residential property that is let (
PIM2050).

There is more about relief for capital expenditure at
PIM3000 onwards.

When there is capital improvement

It is largely a question of fact and degree in each case whether
expenditure on a property leads to an improvement.

Sometimes the improvement may be so small as to count as
incidental to a repair. In the absence of other capital
indications, the entire cost is then revenue expenditure.

Problems can arise where the taxpayer does work on an old
asset. A repair or replacement of a part of a building using modern
materials may give an apparent element of improvement because of
the greater durability, superior qualities and so forth of the new
material. But the cost normally remains revenue expenditure where
any improvement arises only because the taxpayer uses new materials
that are broadly equivalent to the old materials.

For example, the following are usually revenue expenses in
the absence of any other capital indications. The cost of
replacing:

wooden beams with steel girders, and

lead pipes with copper or plastic
pipes.

There is likely to be capital expenditure if, say, the steel
girders were designed to take heavier loads so that the building
could take larger machines after the work was done. The same is
true if the new pipes are designed to take greater pressure or
heat.

But there is usually no improvement if trivial increases in
performance or capacity arise solely from the replacement of old
materials with newer but broadly equivalent materials. For example,
the replacement of pipes or storage tanks of imperial measure with
the closest metric equivalent may result in slightly increased
diameter or capacity but the cost is still revenue expenditure.

Where a significant improvement arises from the change of
materials, the whole of the cost is capital expenditure. This
includes things like redecoration after the main work has been done
(redecoration would ordinarily be a revenue expense). The entire
cost is capital expenditure, including the expense of making good
any damage to decorations.

Extensive alterations to a property

Alterations to a building may be so extensive as to amount to
the reconstruction of the property. This will be capital
expenditure and it can’t be deducted as an ordinary revenue
business expense. Rebuilding, whether forced on the taxpayer or
voluntarily undertaken, is capital expenditure and the whole cost
can’t be deducted in computing profits. Only the actual cost
of normal revenue repairs to a part of the old building that is
preserved in the rebuilt structure is allowable as an ordinary
revenue business expense. But:

the whole of a payment is not necessarily
either capital or revenue; it may be possible to split it between
capital and revenue items - see below.

Capital work and revenue repairs at the same time

Work commissioned on a property may include expenditure on
capital works and also separate expenditure on repairs at the same
time. Here the expenditure on repairs remains allowable.
Expenditure may be apportioned on a reasonable basis to estimate
the amount attributable to the repair element. An apportionment in
the contractor’s bill may provide a sensible basis for
splitting the total; but it must be done fairly and the figures
will be open to review if, say, capital expenditure is wrongly
described as revenue expenditure on repairs.

Repairs etc after a property is acquired

Repairs to reinstate a worn or dilapidated asset are usually
deductible as revenue expenditure. The mere fact that the taxpayer
bought the asset not long before the repairs are made does not in
itself make the repair a capital expense. But a change of ownership
combined with one or more additional factors may mean the
expenditure is capital. Examples of such factors are:

A property acquired that wasn’t in a
fit state for use in the business until the repairs had been
carried out or that couldn’t continue to be let without
repairs being made shortly after acquisition.

The price paid for the property was
substantially reduced because of its dilapidated state. A deduction
isn’t denied where the purchase price merely reflects the
reduced value of the asset due to normal wear and tear (for
example, between normal exterior painting cycles). This is so even
if the taxpayer makes the repairs just after they acquire the
asset.

The taxpayer makes an agreement that
commits them to reinstate the property to a good state of repair.
For example, Fred is granted a 21-year lease of a property in a
poor state of repair by his landlord that he, in turn, sublets.
When Fred’s landlord grants him the lease Fred agrees that he
will refurbish the property. Fred’s expenditure on making
good will be capital expenditure and not allowable. But
Fred’s landlord may be chargeable on the value of the work
under the premiums rules (
PIM1200 onwards) and Fred may qualify for
some relief (see
PIM2300 onwards). See below if payments
for dilapidations are made to the landlord at the end of the
lease.

It isn’t necessary for all these factors to be present for
the expenditure to be capital. The underlying principle is that the
cost of buying a property in good condition is clearly capital
expenditure. Hence the cost of buying a dilapidated property and
putting it in good order is also capital expenditure.

Where the taxpayer is granted a lease of a property in good
repair, the expenses they incur in keeping it in that state will
normally be deductible. This generally includes a payment they make
to their landlord at the end of their lease on account of repairs
which were due but which they had not made. These over-due repairs
are called ‘dilapidations’.

Provisions for repairs to premises

A taxpayer can deduct expenditure on repairs where the liability
to pay for the work is incurred during the tax year but payment has
not been made by 5 April. But a provision for repairs to premises
that they propose to incur in the future is not deductible. For
example, they can’t claim a deduction for repair work they
think will need doing next year but which they have not yet
incurred any liability to pay.

Repairs to assets on which capital allowances were claimed

The taxpayer’s right to a repairs deduction is not lost
because they had, or are getting, capital allowances on the asset
as a whole.

For example, suppose the taxpayer replaces a chimney that is
a physical part of a factory building. This is usually a revenue
expense where the new chimney is a repair to the factory, there is
no improvement - the factory was not bought in a dilapidated state.
If it is a repair, the taxpayer can deduct the cost even though
industrial buildings allowance was due on the cost of constructing
the factory.

No further capital allowance is due on the repair expenditure
if it qualifies as a revenue expense. On the other hand, if the
expenditure on the new factory chimney is capital expenditure, the
taxpayer may be able to claim industrial buildings allowance on
it.

Grants received

Generally any grants the taxpayer gets towards, say, the cost of
revenue expenditure on repairs must be included in their rental
business profits. Grants towards capital expenditure must similarly
be deducted in arriving at the expenditure that qualifies for
capital allowances.

Timing of deduction

The normal trading income rules apply (with the exception of
ESC/B4 which applied to Schedule A property income but not to
trading income until April 2001 - see below). For further guidance
see BIM46901.

Repairs covered by insurance

The landlord may have an insurance policy that covers the cost
of some repairs. If so, you should allow as a deduction only the
excess of the cost over the amount of the insurance recovery.
Sometimes this is achieved in accounts by deducting the expense
when it is incurred, and crediting the insurance recovery as a
receipt when it is received. You may accept this approach. (We
adopt similar principles for traders - see BIM40755.)

Tenants' contributions to maintenance costs

ICTA88/S24 (6) (b) and ITTOIA05/S266 (2) provide that
‘rents’ includes payments by the tenant for work to
maintain or repair leased premises which the lease does not require
the tenant to carry out.

Where a tenant is required to make such contribution,
therefore, the amounts received by the landlord are taxable in
full. The cost of repairs is allowable in full. It is incorrect to
set one off against the other, and the correct treatment may
produce a different result (as the repairs expenditure may well be
incurred in a later chargeable period).

Where the tenant’s contributions are paid into a trust
fund, see
PIM1070.

Dilapidations

The landlord of a property let on a tenants repairing lease
usually inspects the property before the lease is due to expire and
may send the tenant a list of repairs which should have been
carried out under the terms of the lease but which have not, in
fact, been done. Instead of doing the repairs, the tenant may make
a payment to the landlord.

Where the landlord then disposes of the
property or occupies it himself, the payment is likely to be
treated as a capital receipt by way of compensation for failing to
observe the terms of the lease as a result of which the property
reverted to the landlord in a dilapidated condition. The sum paid
to the landlord may then be chargeable, in his hands, to CGT.

Otherwise, the payment is likely to have
the effect of filling a hole in the landlord's profits (ie
compensation for the lower rent the property can now command) and
the payment should be treated as a receipt of the rental business.
The Privy Council case in 1976 of Raja's Commercial College v Gian
Singh supports the view that, for a rental business, it is
appropriate to treat such receipts as taxable because they plug a
hole in the landlord's income as opposed to the landlord's
capital.

Alternatively, the tenant may pay a sum towards the cost to the
landlord of carrying out the repairs required. In that case, the
landlord should only get a deduction for the net cost he bears.

Improvements to a property and ‘notional repairs’:
ESC/B4: periods to April 2001

An alteration may not amount to a reconstruction of the whole
property but the expenditure may still be capital expenditure
because there is an improvement to the property.

For periods up to April 2001, ESC/B4 gave a measure of
revenue relief where capital improvement expenditure saved the need
for repairs expenditure. That is, either repairs to the old
fittings were avoided or, but for the installation of improved
fittings, expenditure on equivalent replacements would have been
needed. ESC/B4 permits a deduction for the part of the capital
expenditure that saves the estimated cost of the repair that would
otherwise have been needed.

Another example is the cost of alterations made to reduce
fire risks, perhaps to satisfy a local fire authority. Expenditure
incurred on additional exits or fire escapes does not of itself
qualify as a revenue deduction but the work may have obviated the
need for some repairs. (Plant and machinery capital allowances may
also be available for certified fire safety expenditure incurred on
hotels and boarding houses.)

Where the alterations are so extensive as to amount to the
reconstruction of the property, only the actual cost of repairs to
any part of the old building incorporated in the new may be
allowed. The cost of notional repairs (for example, decorations) on
the new alterations isn’t deductible.

Notional repairs deduction: ESC/B4

The current property income rules, which apply from 6 April 1995
onwards, brought the IT computational rules for income from
property more into line with the computational rules for
calculating trading income. ESC/B4 ceased to have effect from April
2001, (see press release PR33/98).

The notional repairs concession only applied to the
computation of rental business profits. It did not apply to the
computation of trading profits.

TB59 Schedule A: computation of profits: repairs to let
property

Following the withdrawal, from April 2001, of ESC/B4
(maintenance and repairs of property obviated by alterations etc:
Schedule A assessments) we have been asked for more guidance on
what constitutes an allowable repair for Schedule A purposes.

Background: computation of Schedule A profits

New rules for computing the profits of a Schedule A business
were introduced by FA95 for individuals and by FA98 for companies.
Broadly speaking, the profits of a Schedule A business are now
computed in the same way as the profits of a trade. This means that
the starting point for the computation is a set of accounts drawn
up in accordance with generally accepted accounting practice. The
profit or loss shown by the accounts is then subject to any
adjustments required or authorised by law.

In certain small cases the ‘cash basis’ can be
used as an alternative to the ‘earnings basis’. The
circumstances are set out in
PIM1101.

Whatever basis is used the accounts have to be examined to
see whether or not any expenditure falls to be excluded by specific
tax legislation as explained in the relevant case law. Broadly
speaking expenses are allowable provided they are incurred wholly
and exclusively for the purposes of a Schedule A business and are
not capital expenditure.

This article clarifies what type of expenditure on building
work undertaken on a let property is allowable and what is not.

Capital expenditure

The cost of the house or block of flats that is being let is
capital expenditure and so is the cost of any additions or
improvements. So if you add to the premises something that was not
there before, for example if you build an extension or a new porch,
this is capital expenditure. It does not matter how small the
addition is. If you add an extractor fan or fit an additional
cabinet in the bathroom or kitchen, this is also capital
expenditure.

A landlord is most likely to incur capital expenditure before
a property is let for the first time or between lettings. For
example the landlord may decide to improve the property by creating
ensuite facilities where there were none before. This is capital
expenditure.

Repairs to let property

To decide whether expenditure incurred on ‘repairs’
to property is allowable, the first step is to identify the
‘entirety’ that is being repaired. The doctrine of the
‘entirety’ has been well summarised by Buckley, LJ in
Lurcott v Wakeley (1911) AER 41 as follows:

"
Repair is restoration by renewal or
replacement of subsidiary parts of the whole. Renewal, as
distinguished from repair, is reconstruction of the entirety,
meaning by the entirety not necessarily the whole, but
substantially the whole subject matter under discussion... it
follows that the question of repair is in every case one of degree,
and the test is whether the act to be done is one which in
substance is the renewal or replacement of defective parts or the
renewal or replacement of substantially the whole."

In the case of residential accommodation we accept that the
‘entirety’ will normally be the house or the block of
flats that is let. So if your roof is damaged and you replace the
damaged area, your expenditure is allowable.

Even if the repairs are substantial, that does not of itself
make them capital for tax purposes, provided the character of the
asset remains unchanged. For example, if a fitted kitchen is
refurbished the type of work carried out might include the
stripping out and replacement of base units, wall units, sink etc.,
re-tiling, work top replacement, repairs to floor coverings and
associated re-plastering and re-wiring. Provided the kitchen is
replaced with a similar standard kitchen then this is a repair and
the expenditure is allowable. If at the same time additional
cabinets are fitted, increasing the storage space, or extra
equipment is installed, then this element is a capital addition and
not allowable (applying whatever apportionment basis is reasonable
on the facts). But if the whole kitchen is substantially upgraded,
for example if standard units are replaced by expensive customised
items using high quality materials, the whole expenditure will be
capital. There is no longer any relief for ‘notional
repairs’, which is the notional cost of the repairs that
would otherwise have had to be carried out.

What we regard as a repair will necessarily change with the
passage of time to reflect technological improvements. This issue
was considered in the tax case Conn v Robins Brothers Ltd [1966]
43TC266. As a result we accept that the replacement of a part of
the ‘entirety’ with the nearest modern equivalent is
allowable as a repair for tax purposes and not disallowable as
improvement expenditure.

An example is double-glazing. In the past we took the view
that replacing single-glazed windows with double-glazed windows was
an improvement and therefore capital expenditure. But times have
changed. Building standards have improved and the types of
replacement windows available from retailers have changed. We now
accept that replacing single-glazed windows by double-glazed
equivalents counts as allowable expenditure on repairs.

Generally, if the replacement of a part of the
‘entirety’ is like-for-like or the nearest modern
equivalent, we accept the expenditure is allowable revenue
expenditure.

Further guidance

For more detailed guidance see BIM35450, BIM35460, BIM35465 and
BIM46900 onwards.